What is Pledging of Shares? And Why it can be Dangerous?

Hi Investors. The pledging of shares is one of the many important factors to check before investing- which many investors overlook. A high pledging of shares can be a point of concern for the shareholders.

In this post, we are going to discuss what exactly is pledging of shares and why it can be troublesome for investors. Here are the topics that we will discuss today:

What is pledging of shares?

Why promoters pledge their shares?

Why is pledging of shares risky for the shareholders?

How to find the pledging of shares for Indian companies?

Bottom line

This is going to be an interesting post and I’m confident that you’ll learn many new things concerning pledging of shares in this post. So, without wasting any further time, let’s get started.

1. What is Pledging of shares?

In simple words, pledging of shares means taking loans against the shares that one holds.

This is a way for the promoters of a company to get loans to meet their business or personal requirements by keeping their shares as collateral to lenders. Pledging of shares can be used to meet different needs like working capital requirements, funding other ventures, to carry out new acquisitions, personal obligations and more.

2. Why promoters pledge their shares?

As discussed above, the promoters can pledge their shares in order to meet various business or personal requirements.

Generally, pledging of shares is the last option for the promoters to raise fund. It is comparatively safer to raise fund through equity or debt for the promoter. However, if the promoters are looking forward to pledging their shares, then it means that all the other options of raising fund have been closed.

These situations occur during the economic slowdown. As shares are also considered as assets, hence it can be used as a security to take loans from the banks.

3. Why is pledging of shares risky for the shareholders?

While pledging of shares, the promoters use their stake as a collateral to get the secured loans.

During a bull market, pledging of shares may not create many issues as the market is moving upwards and the investors are optimistic. However, the problem arises in the bear market.

As the price of stocks keeps fluctuating, the value of the collateral (against the secured loan) also changes with the change in the share price. However, the promoters are required to maintain the value of that collateral.

If the price of the shares falls, the value of the collateral will also erode. In order to meet up the difference in the collateral value, the promoters have to cover the shortfall by either giving additional cash or pledging more shares to the lender.

Collateral Value (while taking the loan)

The collateral value after a 30% fall in share price

The collateral value after a 50% fall in share price

Real-time value

100 Crores

70 Crores

50 Crores

Remark

No Issue

More pledging of shares to cover up the difference of the remaining 30 crores

Higher pledging of shares to cover up the difference of the remaining 50 crores

In the worst case, if the promoters fail to make up for the difference, the lender can sell the pledged shares in the open market to recover their money. This minimum collateral value is agreed in the contract between the lenders and the promoters. Hence, it gives the right to the lender to sell the pledged shares in the if the value falls below the minimum value.

What is the risk for the retail investors?

In general, the stock price can fall heavily on the news that lenders are selling shares in the open market that are pledged by the company’s promoters. This may result in a further decline in the collateral value because of the panic selling by the public.

In addition, selling of the pledged shares by the lenders may also result in the change of the shareholding pattern of the company. This may affect the voting power of the promoters as they are holding fewer shares now and their ability to make crucial decisions.

Moreover, pledging of shares can create a disaster if the share price continues to fall. This is because the promoters have to consistently pledge more shares to cover up the difference in the collateral value.

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4. How to find the pledging of shares for Indian companies?

You can find the pledged share as the percentage of total holding sharing shares on most of the major financial websites like moneycontrol, screener etc.

However, the best source to find the pledging of Indian shares would be the BSE or NSE website. Publically listed companies are obliged to submit their quarterly shareholding pattern to the stock exchanges. Hence you can find the latest (and correct) information regarding their shareholding pattern on the BSE/NSE website.

Here are the exact steps to find the pledging of shares for the Indian public companies.

5. Bottom line

Pledging of shares is generally seen in the companies where the shareholding of the promoters is high. As a thumb rule, pledging of shares above 50% can risky for the promoters. In short, ignore companies with high pledging of shares to avoid unnecessary troubles.

This is because pledging of shares is a sign of poor cash flow, low-creditability high-debt company and inability to meet the short-term requirements. (If the promoters have pledged a high percentage of shares, then it’s always worthwhile to find out the reason.) A decreasing pledging of shares over time is a good sign for the investors. On the other hand, an increasing pledging of shares can be dangerous for both promoters and shareholders. Even quality companies can become a victim if the pledging of shares is not reduced over time.

Nevertheless, pledging of shares is not always bad for the companies. You can understand this by relating with your personal loans. For example, taking an educational loan, car loan, house loan is not a big issue if you have a steady income or an amazing future earning prospects.

Similarly, if the company has an increasing operating cash flow and good future prospects, then pledging of shares is not a big concern for them. Many times, pledging of shares helps in the expansion of the company or to carry out new projects which result in increased revenue in the future. Moreover, 5-10% pledging of shares in fundamentally healthy companies should not be considered as a problem.

Anyways, the bottom line is to try avoiding to invest in companies with a high (or increasing) pledging of shares.

That’s all for this post. I hope it was helpful to you. Happy Investing!

Hi, I am Kritesh, an NSE Certified Equity Fundamental Analyst and an electrical engineer (NIT Warangal) by qualification. I have a passion for stocks and have spent my last 4+ years learning, investing and educating people about stock market investing. And so, I am delighted to share my learnings with you. #HappyInvesting

Very informative blog post. Each and every facts of pledging of shares is mentioned here and how it can be dangerous for an investor. An investor should know each and every risk of share market before entering it. Not a single thing can be ignored here.